Value investors scour thousands of stocks to find bargains, also known as value stocks, which they believe are undervalued by the market. However, at the same time, there are value traps, which attract value buyers due to their cheap valuations; however its stock price never recovers
Value investing is a strategy of identifying stocks that trade for less than their intrinsic value. Value investors would scour thousands of stocks to find bargains, also known as value stocks, which they believe are undervalued by the market. The standard approach is to compare the market price of a stock with its fundamentals, using valuation ratios such as the price-to-earnings (P/E) ratio, or the price-to-book (P/B) ratio.
Consider an example to illustrate the use of the P/E ratio to identify value stocks. The P/E ratio of a stock is calculated by dividing market price of the share by its trailing 12 months’ earnings per share. As on 22 January 2016, the average P/E ratio of the NIFTY stocks was around 20. It means that the average NIFTY stock was trading at around 20 times its earnings per share. At the same time, the share price for Punjab National Bank (PNB), for example, was Rs92.55 with a trailing 12-month earnings per share of Rs12.34. Therefore, the P/E ratio for the PNB scrip was 7.5 (92.55/12.34 =7.5). The PNB stock seems cheap as it is trading at just 7.5 times its earnings per share. In fact, we can extend this reasoning and claim that since a typical NIFTY stock trades at 20 times its earnings per share, the market price of the PNB stock should have been around Rs246 (20x12.34 =246). Therefore, the PNB stock appears to be quite a bargain at Rs92.55.
The concept of value investing is not only logically appealing, but it is also supported by the works of leading academic researchers such as Eugene Fama, a Nobel laureate in economics. The lure of beating the market by finding cheap stocks is so compelling that value investing has transformed into a modern-era gold rush, endorsed by an army of investors and experts. It doesn’t hurt that some of the most successful investors of our times, from Warren Buffett to Rakesh Jhunjhunwala, consider value investing as their key to success. Computing valuation ratios for a large number of stocks may be tedious for most retail investors. To put it in perspective, there are more than 5,500 stocks listed on the BSE alone. Fortunately, there are free websites that screen value stocks from the set all listed stocks. For example, one may visit the website Screener.in, and instantly search for all the stocks that have a P/E ratio less than 10.
But if it is so simple and widely practised, why aren’t most of us making money by buying cheap stocks? Sometimes when a company’s share is trading at very low P/E values, it is doing so for a good reason — because its business holds little promise for the future. Such stocks, also known as value traps, would attract value buyers due to their cheap valuations; however the stock prices never recover, and may even fall in the future. Identifying value traps is tricky, even for some of the smartest investors. In 2012, faced with intense competition, the shares of British retail giant Tesco began to slide. Sensing very attractive valuations, Warren Buffett-led Berkshire Hathaway invested heavily in Tesco, eventually becoming its third largest shareholder. However, Tesco’s share price did not recover, and Berkshire Hathaway was forced to liquidate its stake in Tesco at a loss of $444 million. Fortunately, a careful analysis can reveal red flags that indicate a potential value trap. Even if a company’s valuation seems very low, investors should avoid its stock if the company has unsustainably high level of debt, extremely low margins, excessive competition, or when the industry itself is in a steady decline.
Another common mistake is comparing valuation ratios of stocks belonging to different industries. The P/E ratios can vary considerably across different industries. Currently, the average P/E ratio for FMCG stocks is around 41, whereas the same for banking stocks is around 19. This means that ITC, with its current P/E ratio of 25.5, is undervalued relative to its peers in the FMCG industry, whereas IndusInd Bank, with a P/E ratio of 23.3, is overvalued relative to other banking stocks.
Investors must also recognize a basic flaw in the valuation ratios; while the price of the stock changes constantly in response to new developments; the fundamentals such as earnings are only updated quarterly. For example, on 28 May 2015 Nestle India stock traded at Rs7,099. At the time, as per the most recent quarterly results declared for March 2015, the trailing 12-months earnings per share for Nestle India was Rs132, leading to a P/E ratio of 53.7 (7099/132=53.7). While the P/E ratio of 53.7 is healthy, it is not unusually high for the FMCG industry. On 31 May 2015, a criminal complaint was filed against Nestle India for having high levels of lead in its flagship product, Maggi noodles. The Food Safety and Standards Authority of India (FSSAI) banned Maggi noodles, terming them “unsafe and hazardous for human consumption”. Within 10 days, the stock price of Nestle India fell from Rs7,099 to Rs5,504 per share, and the P/E ratio fell from 53.7 to 41.6 (5,504/132 = 41.6). Did this mean that the Nestle India stock had suddenly become cheap? The ban on Maggi noodles was damaging for Nestle India’s stock price, but it was also detrimental for its future earnings prospects. However, while the price (numerator) had immediately fallen in response to the news, the trailing 12-month earnings per share (denominator) remained the same until Nestle India reported its next quarterly results on 30 July 2015. In the quarter ending June 2015, Nestle India reported a loss of Rs64 crore, its first quarterly loss in past 15 years. With this reduction in its earnings, the P/E ratio increased to 68.22 on 30 July 2015, and the stock price of Nestle India no longer looked undervalued relative to its earnings.
(Prateek Sharma is Assistant Professor of Finance at IMT, Ghaziabad)
PACL not only roped in Brett Lee as its brand ambassador, but also invested millions of dollars in Australia. Also, the Ponzi company's directors, including promoter Bhangoo's daughter and son-in-law, were seen living in lavish properties in Australia
PACL Ltd, formerly known as Pearl Agrotech, which has been asked to repay about Rs55,000 crore by the regulators, not only used services of cricketer Brett Lee as its brand ambassador, but also invested millions of dollars in Australia, reveals a report from The Australian.
Pearls promised generous returns to investors by supposedly rehabilitating degraded agricultural land and turning it into prime productive farming country and collected around Rs49,000 crore from investors. "Instead, the money went into the pockets of the directors, who lived lavish lifestyles and bought television stations, Indian cricket teams and invested the money in assets for themselves, including hotels and properties in Australia," the report says.
The Justice RM Lodha Committee appointed by market regulator Securities and Exchange Board of India’s (SEBI) is also looking into investment made by PACL in Australia. The report says, "Their investigations will include the 2009 purchase of the Sheraton Mirage on the Gold Coast. Mr (Nirmal Singh Bhangoo, founder of PACL) Bhangoo spent $62 million buying the resort and $20 million more renovating it. The Sheraton, of course, is Christopher Skase's old haunt."
According to the report, in Australia, Mr Bhangoo and several of his family members teamed up with Gold Coast property developers Paul Brinsmead and Peter Madrers. The two Australians had operated the company Resort Corp, which developed large tracts of coastal land in the Tweed Shire in northern NSW before its group of 14 companies collapsed in March 2009, owing about $300 million, it said.
"Six months later, while administrators were still sorting through the wreckage of Resort Corp, Mr Brinsmead and Mr Madrers founded Pearls Australasia with Mr Bhangoo, his son Harvinder Singh Bhangoo and son-in-law Gurpartap Singh. Later Mr Bhangoo's other daughter Barinder Kaur and her husband, Harsatinder Singh Hayer, also joined the company as directors."
"In September 2014, Pearls Australasia changed its name to MiiGroup Holdings and refers to itself collectively as the MiiGroup of companies. These companies are all based in a waterfront office at Bundall on the Gold Coast. Also, operating from the same address is Shac Communications, the public relations firm that represents MiiGroup Holdings and undertook the "full rebrand for the group" in 2014. The managing director and owner of Shac Communications is Simone Holzapfel, who was Tony Abbott's chief political adviser for six years during the Howard government," the report from The Australian says.
MiiGroup, however, has distanced itself from the PACL scam and investigation going on in India. In a statement, it called itself as an Australian company with diverse business with Pearls Infrastructure Projects (PIPL) as a passive investor in some of its businesses. "...the individuals and companies associated with PIPL in India have no control and do not take part in any day-to-day operations of the independent and separately owned Australian MiiGroup. Any allegation that MiiGroup Australia is an Indian company or a subsidiary of an Indian company is false. Any allegation that any events in India are related to individuals or companies associated with PIPL are in any way relevant to or connected with MiiGroup, or that Mii Group is controlled or managed by any of these entities, is false," the statement reads.
In its report, the newspaper said, based on company searches, Mr Bhangoo's daughter Barinder and her husband Mr Hayer, live in a multimillion-dollar Gold Coast mansion. The property in the suburb of Hope Island boasts six bathrooms and five garages and was bought, along with an adjacent vacant block, for $4.95 million in 2011 by a company called Pearls Infrastructure Projects.
Quoting P Venugopal, senior counsel for SEBI, the report said, "I do not think we will ever be able to recover much. Because basically, according to us, the entire operation was just a money laundering exercise. The Central Bureau of Investigation (CBI) is investigating celebrities who were involved with the (Pearls) schemes and yes, (cricketers) Harbhajan Singh and Yuvraj Singh are under investigation with respect to the plots at Mohali (in Punjab) received by them from the company."
In 2010, PACL roped in Australian speedster Brett Lee as its brand ambassador. During a press conference announcing his appointment, Lee had reportedly said, "It's not about only being a brand ambassador, but I am proud to be a family member of Pearls Group. I feel every person is being touched by Pearls around the world. I certainly believe that Pearls is the best."
In the advertising campaign, Lee was filmed building sandcastles with kids and jogging on a beach in Goa. "He stood in front of a camera dressed in a white sports coat and recited the firm's mantra: 'Touching hearts, building confidence. Pearls Infrastructure', the news report says.
"What he should have said was "touching wallets, breaking hearts", for while there is no suggestion that Lee had any knowledge of this at the time, the company he was spiking was allegedly engaged in a monumental fraud," it added.
While Lee's manager at that time, Neil Maxwell, who negotiated the deal with PACL, and current manager, Jake Elder have denied any wrongdoing on part of the cricketer. The fast bowler's website, Brett-Lee.net still lists Pearls India as one of the brands represented by him. It says, "(Lee is) a brand ambassador across the Pearls group, representing Pearls Infrastructure Group, P7 News, Pearls Tourism & Pearls Spices."
SEBI's counsel Venupgopal told the newspaper that officials from the Australasian Consumer Fraud Taskforce, an umbrella body whose members include the Australian Federal Police and the Attorney-General's Department, had recently contacted him to discuss the alleged fraud and its implications in Australia.
He also told the newspaper that directors of PACL used Russian banks to send money (collected from investors) overseas, including Australia and it would be very difficult to follow the trail.
According to the newspaper report, the Australian arm of Pearls was adept at working political connections. In October 2010, as part of a trade mission and Australia's 2018 Commonwealth Games bid, a delegation led by then Queensland premier Anna Bligh and including then high commissioner to India Peter Varghese met with the Pearls Group, it said.
"A record of the meeting shows that in attendance were Pearls Group directors; Mr Bhangoo's other daughter Sukhwinder Singh and her husband Gurpartap Singh; 'group general manager' of Pearls Group Rikhab Jai; and 'Pearls Australia joint managing directors' Mr Brinsmead and Mr Madrers. Records show the meeting was 'designed to encourage the Pearls Group to increase its investment portfolio in Queensland' and Pearls Group was stated as having '1.6 million employees across its various entities'. The records show Ms Bligh directly dealt with requests from members of the Bhangoo family to obtain 'state-sponsored' visas," the report from The Australian says.
Earlier, SEBI, as part of its recovery proceedings, attached all bank and demat accounts, mutual fund portfolios of PACL and it eight directors and promoters. In a release, SEBI said, the recovery proceedings have been initiated for their failure to comply with its order issued on 22 August 2014 directing, PACL and its directors and promoters to wind up the schemes, and refund Rs49,100 crore to the investors within three months from the date of the order. This amount is excluding further interest and all costs, charges and expenses incurred in the recovery proceedings.
According to SEBI, the amount due to investors of PACL would be over Rs55,000 crore. This includes promised returns, further interest, all costs, charges and expenses incurred in respect of all the proceedings taken for recovery of Rs49,100 crore from PACL.
The mobilisation of funds by PACL traces back prior to 1997. Upon receipt of a complaint, SEBI on 30 November 1999 and 10 December 1999 issued letters asking PACL to comply with the provisions of the collective investment scheme (CIS) Regulations.
PACL challenged these letters before the High Court of Rajasthan in December 1999, claiming that its scheme does not fall under the definition of CIS as defined under the CIS Regulation and SEBI Act. PACL also challenged the constitutional validity of the CIS Regulations.
The Rajasthan High Court on 28 November 2003, held that PACL's schemes were not CIS as defined under Section 11AA of the SEBI Act. The HC also quashed SEBI's letters issued to PACL.
SEBI filed an appeal before the Supreme Court against the order of Rajasthan HC. The SC on 25 February 2013, while allowing the appeal upheld the constitutional validity of CIS Regulations, and directed SEBI to investigate the matter and take appropriate actions.
After conducting an inquiry, SEBI on 22 August 2014, issued an order directing PACL, its promoters and directors to wind up all the existing CIS and refund the monies collected by the company to investors as per the terms of offer within a period of three months from the date of the Order.
PACL filed an appeal before the Securities Appellate Tribunal (SAT), which was dismissed on 12 August 2015. The SAT directed PACL and its promoters-directors to refund the money within three months. Since the company and its promoters-directors failed to refund the money to the investors as per the directions of SEBI and SAT, the market regulator said it has initiated the recovery proceedings.
New Delhi : India's Income Tax department has issued refunds of Rs.1 lakh crore in the current fiscal up to January this year, a senior official said on Monday.
"The Income Tax department has so far issued refunds of Rs.1 lakh crore to 1.75 crore assessees in 10 months of the 2015-16 fiscal," Revenue Secretary Hasmukh Adhia said in a tweet.
The government directed the department in December 2015 to quickly settle the refund claims of amounts less than Rs.50,000.
As of November 1, refunds had to be made to 207,000 Income Tax returnees involving Rs.659 crore for the assessment year 2013-14 and another set of 1.29 million returnees involving Rs.4,837 crore for 2014-15.
"This (refund) has been a major relief to taxpayers. This demonstrates the government's intention to create a tax-friendly environment," Adhia said.
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.